When to Refinance Your Mortgage: When Does It Make Sense?

Short answer: When to refinance comes down to one test: will the money you save each month repay your closing costs before you sell or pay off the home? Divide your closing costs by your monthly savings to get your break-even point. The CFPB's home loan toolkit cites a common rule of thumb: refinance only if the lower rate pays those costs back in about two years.

When Does Refinancing Make Sense?

Refinancing replaces your current mortgage with a new one. A 2008 Federal Reserve consumer guide lists the main reasons people do it:

• To get a lower interest rate. A lower rate usually means a lower monthly payment, and it may help you build equity faster.
• To shorten the term. Shorter loans usually carry lower rates and cost less total interest, but the monthly payment usually goes up.
• To switch from an adjustable rate to a fixed rate. A fixed rate gives you a steady payment.
• To get a better adjustable-rate loan, for example one with a lower starting rate or smaller rate adjustments and payment caps.
• To take cash out of your home equity, which leaves you owning less of your home.

A better rate alone isn't enough. Refinancing costs money up front, so the savings have to last long enough to cover those costs. That's why how long you plan to stay in the home matters as much as the rate.

The CFPB's home loan toolkit also notes that you may be able to refinance later if rates fall or your credit or financial situation improves. If errors on your credit report are holding your score down, our guide to disputing credit report errors explains how to fix them before you apply.

How Do You Calculate Your Refinance Break-Even Point?

Use this simple formula from the Federal Reserve guide:

Break-even point (months) = total closing costs ÷ monthly savings

The Fed's own example: a refinance that costs $2,500 and saves $91 a month after taxes takes about 27 months to break even. If you expect to move before then, the refinance would cost more than it saves.

The CFPB's toolkit cites a common rule of thumb: compare the cost of refinancing with what you paid in closing costs on your purchase loan, since a refinance can cost about that much, and proceed only if the new rate saves you that amount in about two years.

To see how much a rate change moves your payment, the Fed guide compares a $200,000, 30-year loan at 6.0% and at 5.5%. The lower rate cuts the payment by $63 a month, or $7,560 over 10 years. Our mortgage payment calculator lets you run the same comparison with your own loan amount and rates.

How Much Does Refinancing a Mortgage Cost?

Refinancing comes with closing costs much like the ones you paid when you bought your home. The Federal Reserve guide (2008) said total refinancing fees often run 3% to 6% of the outstanding principal, plus any prepayment penalty. More recently, the CFPB reported in 2023 that certain closing costs and fees that borrowers paid rose 22% from 2021 to $5,954 in 2022.

Typical ranges listed in the Fed guide (2008) include:

Cost	Typical range (Federal Reserve, 2008)
Application fee	$75 to $300
Origination fee	0% to 1.5% of the loan principal
Points (one point is 1% of the loan amount)	0% to 3% of the loan principal
Appraisal	$300 to $700
Inspection	$175 to $350
Attorney or closing fee	$500 to $1,000
Title search and title insurance	$700 to $900
Survey	$150 to $400
Prepayment penalty on the old loan	One to six months' interest

These ranges date from 2008, so use the list as a checklist of fees to ask about rather than as current prices. Your Loan Estimate lists the actual fees for your loan. The CFPB recommends getting at least three offers in writing and comparing the Total Loan Costs, the annual percentage rate (APR) and the total interest percentage (TIP) on each Loan Estimate.

What Is a Rate and Term Refinance?

A rate and term refinance is a refinance with no cash out. HUD's FHA handbook describes no cash-out (rate and term) refinances as transactions where all proceeds are used to pay existing liens and the costs of the transaction.

The other main types:

1. Cash-out refinance. You borrow more than you owe and take the difference in cash. The Federal Reserve guide warns that this reduces your equity and what you'd receive if you sold, and suggests comparing it with a home equity loan or line of credit first.
2. Streamline refinance. HUD describes these as refinances of existing FHA-insured mortgages, made with or without appraisals.
3. Adjustable-rate to fixed-rate refinance. The Federal Reserve guide lists this as a reason to refinance: it swaps a changing rate for a steady payment.

If your goal is to pay the loan off sooner rather than to change the rate, refinancing isn't the only route. Our guide to paying off your mortgage faster covers extra principal payments that don't require a new loan.

Is a No-Closing-Cost Refinance Worth It?

It depends on how long you'll keep the loan, because the costs don't disappear. The CFPB explains that a loan advertised as having no lender fees or no closing costs usually recovers those costs in one of two ways:

• A higher interest rate. The lender gives you a credit to cover closing costs, and you pay more interest over the life of the loan.
• A bigger loan. The closing costs are added to the loan amount, so your payments go up and you build equity more slowly.

The Federal Reserve guide adds that "no-cost" can mean different things to different lenders and that some of these loans carry prepayment penalties. Ask lenders to explain and compare their fees, and the guide suggests getting information in writing about each loan before you pay a nonrefundable fee.

The same trade-off works in reverse with discount points. The CFPB's toolkit explains that you can pay points at closing to get a lower rate, or take lender credits to cover some closing costs in exchange for a higher rate.

When Should You Not Refinance?

Refinancing may not pay off if:

• You plan to move soon. If you sell before the break-even point, the closing costs outweigh the savings.
• You're far into your current loan. Late in a mortgage, more of each payment goes to principal. The Federal Reserve guide notes that a new loan restarts that schedule, so your early payments go mostly to interest again.
• Your current loan has a prepayment penalty. The Fed guide says a penalty lengthens your break-even period. If you refinance with your current lender, you can ask for it to be waived.
• You'd use a cash-out refinance to pay off credit cards or car loans. The Fed guide notes that many financial advisers caution against this.

For homeowners nearing retirement, a refinance is one of several ways to manage housing costs. Our guide to reverse mortgage pros and cons covers another option for older homeowners.

What Happens Before and After Closing?

You should receive your Closing Disclosure at least three days before closing, according to the CFPB's toolkit. Compare it with your Loan Estimate.

A refinance also comes with a short cooling-off period. The toolkit says you have three days to cancel a refinance or home equity line of credit after you receive a notice of your right to rescind.

The Bottom Line

Refinance when the numbers work for your timeline: a lower rate, shorter term or fixed rate that saves enough each month to repay your closing costs well before you expect to move. Divide closing costs by monthly savings, compare at least three Loan Estimates, and remember that a no-closing-cost loan still costs you through the rate or the balance. If you'd like a second opinion on how a refinance fits your wider plans, our guide to what a financial adviser costs explains the common fee types. Our guide to what PMI is explains mortgage insurance, and our home and mortgage guides cover other ways to manage housing costs.

Frequently asked questions

When should you refinance your mortgage?

Refinancing is worth a closer look when a new loan would lower your rate, shorten your term or replace an adjustable rate with a fixed one, and the monthly savings would cover your closing costs well before you expect to move. The CFPB's home loan toolkit cites a common rule of thumb: proceed only if the lower rate pays back those costs in about two years.

How much does refinancing a mortgage cost?

A Federal Reserve consumer guide (2008) said total refinancing fees often run 3% to 6% of the outstanding principal, plus any prepayment penalty. In its review of 2022 mortgage data, the CFPB reported that certain closing costs and fees rose 22% from 2021 to $5,954. Your own Loan Estimate shows the exact figures for your loan.

What is a rate and term refinance?

It's a refinance with no cash out. HUD's FHA handbook describes it as a refinance where all proceeds are used to pay existing liens and the costs of the transaction. You don't take equity out as cash.

Is a no-closing-cost refinance really free?

No. According to the CFPB, the costs still exist. The lender either charges a higher interest rate and gives you a credit to cover closing costs, or adds the closing costs to your loan amount. Either way you pay more over time.

Can I cancel a refinance after I sign?

The CFPB's home loan toolkit says you have three days to cancel a refinance or home equity line of credit after you receive a notice of your right to rescind. Read that notice carefully at closing.

Sources

1. Federal Reserve Board: A Consumer's Guide to Mortgage Refinancings (2008)
2. CFPB: Your Home Loan Toolkit
3. CFPB: Is There Such a Thing as a No-Cost or No-Closing Loan or Refinancing?
4. CFPB: Mortgage Report Finds Jumps in Closing Costs and Denials for Insufficient Income, Growing Proportion of Cash-Out Refinances (2023)
5. HUD: Refinance Transaction Overview (FHA Handbook 4155.1, Chapter 3, Section A)

This guide is general information, not personal advice. Your situation may differ, so consider talking with a qualified professional, such as a fiduciary financial adviser, CPA or licensed agent, before making a decision.